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19-06-2020 | Research Article

The price leadership share: a new measure of price discovery in financial markets

Author: Riccardo De Blasis

Published in: Annals of Finance | Issue 3/2020

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Abstract

We propose a new measure to establish price leadership among multiple related price series using a multivariate Markov chain model. This new measure, the price leadership share (PLS), can easily be calculated when price series are related but not fully cointegrated (e.g. there is a fractional cointegration and the unit root test fails) and with more than two price series simultaneously, offering advantages over the existing price discovery measures. In addition, we propose a price leadership concentration index to help the comparative analysis. The measure is tested on six gold contracts, including spot, futures, and ETF, with a global coverage over a 2-year period. Results show that gold futures contracts, mainly the US contract (CME futures), have a major role in the price discovery function confirming the previous literature’s findings. Overall, the PLS measure overcomes the limits of other existing price discovery measures.

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For a comprehensive review of the price discovery measures with their limits and extensions, we refer the readers to Narayan and Smyth (2015).

This departure from the assumptions of the common efficient price in favour of a direct analysis or prices should not be considered as a step back to the lead-lag models. In fact, the model presented in this paper is based on a probabilistic model, the Markov chain model, therefore, rare spillovers of noise, i.e. temporary price impacts between markets, are less likely to influence the measure.

Markov chain models have been used to model financial markets (Chu et al. 1999), to perform stock valuation (Hurley and Johnson 1994; Yao 1997; Hurley and Johnson 1998; Ghezzi and Piccardi 2003; Barbu et al. 2017), and to model credit rating (D’Amico et al. 2006; Vasileiou and Vassiliou 2006; D’Amico et al. 2016).

See e.g., Niederhoffer and Osborne (1966), Dryden (1969), Fielitz and Bhargava (1973), Mcqueen and Thorley (1991), and Tan and Yılmaz (2002).

Each element of the matrix is a probability and every change from a state i must end in a state j, therefore the matrix is a stochastic matrix.

It is worth noting that if there is no dependency between the price change series, the model still works but the matrix (10) becomes an identity matrix.

The solution applied by Patel et al. (2019) is to keep only permanent price impacts that are non-negative, with the cost of losing possible valuable information.

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Title: The price leadership share: a new measure of price discovery in financial markets
Author: Riccardo De Blasis
Publication date: 19-06-2020
Publisher: Springer Berlin Heidelberg
Published in: Annals of Finance / Issue 3/2020
Print ISSN: 1614-2446
Electronic ISSN: 1614-2454
DOI: https://doi.org/10.1007/s10436-020-00371-3

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